The Pied Pipers of 'Buy High, Sell Higher'

A headline in a business daily talks about Ola cab drivers turning day traders...

The local radio jockey has an opinion on the Sensex...

Business channel gurus are urging revelers to keep the party going...

It is typical to see retail investors show their clout at the peak of bull markets. But it is the pied pipers of the 'buy high, sell higher' strategy - the brokers, fund houses, 'experts', bankers, and media - that encourage such behaviour.

Equity mutual funds saw record inflows in the April to June 2017 quarter. The quarterly surge nearly equaled the increase from all of last year. And about one-tenth of the total 34 million mutual fund folios in June were added in the last quarter alone. Which means lots of first-time investors. These are novices who are jumping into the market at peak valuations. And the pied pipers urge them on citing incremental funds and higher peaks.

Dow 36,000 was the best-selling investment book of 1999. The US index is far from this level even today, but the sentiment has not changed. Investors still want to latch on to a rising market for easy gains. The pied pipers, meanwhile, use FOMO (Fear Of Missing Out) to pressure investors to buy into the market at obscene valuations. Buy high, sell higher, it turns out, is an easy story to sell.

For Indian investors, the upside in corporate earnings has been successful bait. And continues to be. The average profit margins of Indian companies continue to languish near historical lows. But the worry is that the surge in valuations since 2016 has been devoid of profit growth.

Now since earnings are currently unusually low, looking at sales, which are relatively more stable, can give a good sense of how expensive markets are. It turns out the Sensex and the broader BSE 500 indices are close to their peak valuations when measured against sales.

So as much as the pied pipers want to convince lay investors that stocks have more upside, the reality could be starkly different.

Of course, some stocks could correct less than others. Blue chips, for instance, continue to trade at more reasonable valuations than small caps. Meaning their downside risk is less. But buying any stock at its all-time high, ignorant of the downside risk, could be a recipe for disaster. And you may never get the chance to 'sell higher'.

Indices Close to Peak Valuations Measured Against Sales

Editor's note: Even as the Equitymaster analysts grow increasingly wary of market valuations, their bottom-up approach continues to uncover new opportunities...many of which most investors, especially the hordes of novices, have never heard of.

For instance, Richa's Hidden Treasure team has uncovered a batch of small caps that could lead to what Richa calls 'backdoor profits'.

Multinational companies (MNCs), considered to be safe and stable entities, may slowly be losing their mojo. As per an article in Business Standard, the valuation of listed Indian subsidiaries of 23 MNCs has been on a steady decline in the past two years even as overall markets have become pricier. The average valuation of an MNC has fallen to 47.5x its trailing 12 month's earnings as compared to 51x in FY15. During the same period, the valuations of the broad index, excluding financial companies and state-run oil companies, has risen from 27x to 30x. What's more, the premium commanded by the MNCs in India has shrunk even relative to their global parents.

A major reason why MNCs in India are going out of favour is the slowdown in demand and growing competition. In the FMCG segment, competition has intensified with the growing clout of the home-grown players such as Dabur, Marico and Patanjali, whereas price control and regulations have impacted growth in the pharma segment. Barring passenger car market leader Maruti Suzuki, the combined revenues (in dollar terms) of the other MNCs has fallen in the last two years. These include the likes of Hindustan Unilever, Procter & Gamble, Nestle, GSK Consumer, Colgate Palmolive and GSK Pharma.

These large MNC stocks may continue to deliver returns but not like before.

Coming to structural reforms accelerating economic growth in the country, digitisation has received a big leg-up from last years' notebandi. At least the country's largest bank, State Bank of India, claims so. According to it, notebandi helped the nation leapfrog three years ahead in digitisation. During the period between April 2016 and April 2017, the combined debit and credit card transactions shot up by 88% whereas the payments through mobile banking and prepaid wallets surged by 122%.

The SBI report goes on to add that with every Rs 100 billion increase in the value transacted through credit and debit cards, the CPI inflation is expected to fall by 1.1% thereby paving the way for a favourable growth inflation balance in the coming years. The higher digital transactions coupled with the Goods and Services tax regime is likely to foster a transparent and efficient business climate in the country.

Now, the Goods and Services Tax (GST) became the order of the day at the start of this month. And all these months we have been subjected to a relentless propaganda by the government and the supporters of the GST, on how it will change our world, only for good.

Our colleague Vivek Kaul, has studied the finer aspects of the GST and predicted what could go right and wrong.

Indian equity markets opened the day weak and continued to slip deeper in the red. At the time of writing, BSE Sensex was trading lower by 93 points and NSE Nifty was lower by 29 points. Both the mid cap and small cap indices are trading down by 0.2% and 0.7%, respectively. Stocks from the healthcare sectors are witnessing maximum buying interest.

04:56 Investment mantra of the day

You don't need to be an expert in order to achieve satisfactory investment returns. But if you aren't, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don't swing for the fences. When promised quick profits, respond with a quick 'no'. - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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